How do labour laws affect unemployment and the labour share of national income? The experience of six OECD countries, 1970–2010

• Author: Simon DEAKIN,Jonas MALMBERG,Prabirjit SARKAR
• DOI: http://doi.org/10.1111/j.1564-913X.2014.00195.x
• Published date: 01 March 2014
• Date: 01 March 2014

International Labour Review, Vol. 153 (2014), No. 1

Copyright © 2014 The Authors. International Labour Review, published by John Wiley & Sons Ltd

on behalf of the International Labour Organization. This is an open access article under the terms of

the Creative Commons Attribution License, which permits use, distribution and reproduction in any

medium, provided the original work is properly cited.

How do labour laws affect unemployment

and the labour share of national income?

The experience of six OECD countries,

1970–2010

Simon DEAKIN,* Jonas MALMBERG** and Prabirjit SARKAR***

Abstract. Using longitudinal data on labour law in France, Germany, Japan,

Sweden, the United Kingdom and the United States over the period 1970–2010,

the authors estimate the impact of labour regulation on unemployment and the

labour share of national income. Their dynamic panel data analysis distinguishes

between the short-run and long-run effects of regulatory change. They nd that

worker-protective labour laws in general have no consistent relationship to un-

employment but are positively correlated with labour’s share of national income.

Laws specically relating to working time and employee representation are found

to have benecial effects on both efciency and distribution thus proxied.

In this article we present new empirical evidence on the impact of labour

laws on the labour share of national income and unemployment in devel-

oped market economies. The issue is one which has preoccupied economists

and other social scientists for some time, without any clear consensus emerg-

ing. In the 1990s the OECD’s Jobs Study (see OECD, 1994) made the argu-

ment for liberalizing labour laws as part of a strategy for enhancing labour

market exibility and thereby boosting job creation. During the 2000s similar

arguments were made by the World Bank through its Doing Business initia-

tives (World Bank, various years). Economic theory incorporating equilibrium-

based modelling broadly supports these positions, but empirical evidence has

been much more equivocal (Skedinger, 2010). A growing number of studies

suggest that the supposed negative effects of labour laws may be either very

small or simply non-existent (Blanchower, 2001; Baker et al., 2005), and that

* Centre for Business Research (CBR), University of Cambridge, email: s.deakin@cbr.cam.

ac.uk. ** University of Uppsala, email: lars.jonas.malmberg@gmail.com. *** Jadavpur Univer-

sity and CBR, University of Cambridge, email: prabirjit@gmail.com. We are grateful to Aleksandra

Polanska for research assistance and to an anonymous referee for comments on an earlier draft. The

research was supported by the DFID-ESRC Joint Fund on Poverty Alleviation.

Responsibility for opinions expressed in signed articles rests solely with their authors, and

publication does not constitute an endorsement by the ILO.

International Labour Review2

such laws could, in fact, have benecial effects on productivity and innovation

(Acharya, Baghai and Subramanian, 2012a and 201 2b). In the light of this evi-

dence, some scholars have called for a reappraisal of the assumptions under-

lying equilibrium-based models of the labour market (Freeman, 2005).

Our contribution to this debate is an empirical one and makes two meth-

odological innovations. Firstly, we make use of a recently constructed data set,

the Labour Regulation Index of the Centre for Business Research (CBR), which

provides the most detailed and systematic analysis of trends in labour law over

time in major industrialized economies. It differs from the most commonly used

alternatives (the OECD’s Employment Protection Index and the World Bank’s

Employing Workers Index) in providing a continuous time series based on con-

sistent coding of primary legal sources covering the full range of laws govern-

ing individual and collective work relations. Secondly, we analyse the impact

of labour law on the economy using econometric techniques which distinguish

between short-run and long-run effects of legal change and take into account dy-

namic interactions between legal and economic variables. These techniques mark

an advance on the more static cross-sectional and time invariant analyses which

have mostly been used until now to analyse the economic effects of labour laws.

Our study examines the economic effects of labour laws between 1970

and 2010 in six OECD countries, namely, France, Germany, Japan, Sweden, the

United Kingdom and the United States. These countries span the main legal

families (common law and civil law) and the principal “varieties” of market

economy (“liberal market” and “coordinated market” systems). We carry out

a dynamic panel data analysis which shows that labour laws across the board

had no clear long-term or short-term effect on unemployment over this time

span and for these developed market economies. When we break our ana-

lysis down to look more closely at particular kinds of labour law regulation,

we nd strong evidence that laws providing for working time reductions have

the effect of reducing unemployment, and weaker evidence of the same effect

on the part of laws protecting worker representation. Then we look at the im-

pact of labour laws on labour’s share in national income. We nd that worker-

protective labour laws are associated with a higher labour share and therefore,

in broad terms, with improved income distribution – an outcome driven by

laws on working time and employee representation.

The remainder of the article is organized into ve sections. The rst

briey overviews the current state of the debate over the equity–efciency

trade-off in labour law. The second introduces our data. The third section pre-

sents the results of our econometric analysis, and the fourth provides an as-

sessment. The fth section concludes.

Equity and efciency in labour law:

Is a trade-off inevitable?

In the labour law literature, legal protection of workers is typically justied on

the grounds that it reduces or mitigates the effects of the inequality of bargain-

ing power which is inherent in the employment relationship. The central aim